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China-mounting pressures over future GDP growth

Over the past 25 years, gross domestic product (GDP) annual growth rate in China averaged 9.88%. However, woes of a declining momentum in terms of growth continued to hinder investors’ sentiment. This was reflected in market volatility experienced over the past months. The slower demand from the second largest economy kicked-off a series of stimulus measures to try and maintain the current level of growth.

Despite the efforts, a stream of weakening economic figures persisted over the past months which added to the uncertainty on the sustainability of an annual growth rate above 7%. The uncertainty over the ongoing and prospective weakening of fiscal metrics, a continuing fall in reserve buffers due to capital outflows and given the level of uncertainty on the authorities’ capacity to implement reform, has punished China’s financial markets to a certain extent.

The cited increase in government debt to GDP has over the past years increased consistently and reached 40.6% of GDP at the end of 2015 from 32.5% in 2012. In line with the further expected accommodative stimulus, through further government spending, Moody’s forecasts that gross debt to GDP will increase to 43% by 2017.

One other key factor relates to the foreign exchange vulnerability and reserves. China's foreign exchange reserves have fallen markedly over the last 18 months, to $3.2 trillion in January 2016 from the peak figures of just below $4 trillion way back in June 2014. Clearly, despite the still ample reserve FX account, the plunge might be interpreted, within market context, as a signal of weakening confidence in the ability of the authorities to maintain economic growth and implement reforms.

In addition, if reserves uphold their declining momentum, in line with intent to preserve the value of the currency, this might tighten liquidity in China and impact the debt service capabilities. Other than that a depreciation in the currency is also likely to trigger further capital outflows.

Thus over the past months in line with a weakening economy, a series of easing measures were adopted. The most cited and the one which mostly shook markets across the board was the devaluation of the currency way back in August 2015. The said move had further fueled concerns going forward on China’s sustained growth.

Lately, the People’s Bank of China (PBOC) once again lowered the reserve ratio for banks by an additional 50 bps to 17%, from the 20 per cent level which was kept stable from mid-2012 until December 2014. Thus a further accommodative decision by the PBOC which should create further liquidity through the multiplier effect.

Surely the revision of outlook by Moody’s triggered further concerns, which luckily enough weren’t till date effective over market participants due to the fact that over the last weekend China’s leaders gathered to set their 5-year plan growth targets which seem to be informally flagged at 6.5% to 7% levels. Thus investors are still betting on a new series of easing measures, both fiscal and monetary.

My view is that markets should commence accepting the fact that China’s growth, going forward, can’t be sustained at high levels as it did over the past years, in line with a slowed demand domestically, in addition to other macroeconomic factors globally.

However, looking on the flip-side of the story, despite economically China is passing through a rough patch, one must also depict a larger picture over the long-term. The country still holds one of the highest populations in the world. One other positive measure for the longer-term is the recent decision to abolish the one-child policy, which should, going forward, stimulate further domestic demand. Thus in my view when considering the longer term China should be a good position for investors.

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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